The changing nature and openness of emerging market financial systems mean that constant assessment of the environment is necessary.

MSCI is currently considering whether to increase the allocation of China’s weight in the emerging market index to include the nation’s A shares.

(Concurrently MSCI Korea and MSCI Taiwan Indices remain under review for a potential reclassification to developed markets).

The MSCI emerging market index currently only includes Hong Kong-listed H shares, and some China B shares.

Including the A shares in the index would dramatically change the nature of the benchmark, potentially increasing China’s allocation from around 18 per cent to 30 per cent.

China is already the largest single country weight in the index and this potential change would give it more impact. This obviously has implications for investors.

The Shanghai and Shenzhen stock exchanges have more than 2400 stocks, with a total market capitalisation of about $3.5 trillion.

Foreign ownership is only about 1 per cent of that, due for the most part to the stringent requirements of the Qualified Foreign Institutional Investor system and the slow deployment of its quota.

However MSCI is seeing enough change to conduct consultation on the country’s allocation.

Chin Ping Chia, managing director of MSCI, says a series of developments have caused the review, including an increase in the quote of A shares available to foreigners from $30 billion to $80 billion.

“We see this as a signal to expand the system and allow more investors to participate.”

In addition the high qualification criteria has been amended.

It used to be that to get a licence you needed $5 billion in assets and a five-year track record. That was lowered in July last year to $500 million in assets and a two-year track record.

“This is a significant change and broadens the set of investors, which is a positive thing.”

China’s Renminbi Qualified Foreign Institutional Investor system has also been expanded from RMB70 billion to RMB270 billion.

“This is a positive message saying there is regulatory momentum to open the markets.”

However MSCI identifies a number of key obstacles that need to be overcome, including capital mobility restrictions, the small allocation associated with licences and the imposition of capital gains tax.

“China is the second largest economy in the world. It is very close to opening to international investment and we think this is the right time to be starting this conversation. But it depends entirely on the progress of the regulatory system. MSCI does not have a time frame, but we are engaging with the regulators so they consider the investment processes and needs of investors,” he says.

“It is also for investors to digest and think about the consequences. Only a small handful of investors – 200 – have QFIIs. A large number of investors haven’t taken action, so what does it mean to take action?

“In the context of every market, when they open and increase foreign institution participation it is a good thing. It mainstreams investment ideas and the market gets more efficient.”

Frank Yao, managing director of Neuberger Berman Asia, says it is a huge positive to include the A shares in the index.

“It is positive for international investors to access China. It is the second largest economy in the world, but international investors have no direct way to access it. It is also positive for domestic investors: if foreign investors come, the market becomes more institutionalised.”

In particular, he says, that would mean improvements in technology, corporate governance and transparency.

Yao says the government influence and management of the corporate sector has diminished over the years.

“There is new leadership, economic reforms and now China is being opened to the rest of the world. China will become more market driven. In many areas, like the housing and auto sectors, China is more capitalist than the US,” he says. “Last week the government announced it would open the banking sector. Five or even three years ago you couldn’t even imagine this would happen.”

While China will continue to grow, Yao says it is still an emerging market and is very inefficient.

“Investors need to have a long-term investment horizon and emerging markets are volatile. There are still significant alpha opportunities.”

For more on China in the broader context of emerging markets, read the full story.

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